The tax report seems to reveal a concern/realisation by the group that any tax change causing a significant drop in values in property, will be politically unacceptable. This was a view that I formed and I generally disregarded this option as too radical when I recently read the report.
But it is the government's actions and decision that count.
Risk Free Rate of Return (RFRR)
Example Application of RFRR Tax and Outcome
Here's an example scenario for Joe Bloggs...
He has a rental property and earns $65k, has 2 kids, and a spouse who works part time earning $15k. All household income is required to survive. The rental property is negative cashflow by $7,000 before tax refund, break-even cashflow post tax refund. The market value of the property is $400k, and the debt $350k. Currently Joe and his family get by - paying their living costs and mortgage payments (just). The market equilibrium assumes the tax refund, and hundreds of thousands of 'Joe Bloggs' are doing this.
Enter this tax. Now Joe does not get a tax refund. He has to pay tax on 6% of $400k (MV)-$350k (debt) = $50k which is $3k times 33%, $1k tax. So previously he was getting $7k tax refund, now he pays $1k, meaning he is $8k worse off.
The outcome is he has to sell in a market that is flooded with other Joes. He goes broke and is mortgagee sold. He stops spending and kicks off another recession with the thousands of other Joe Bloggs in the same predicament. They all vote Labour for the rest of their lives and everyone blames National for the massive blunder. The next government throws out the unpopular tax, and the market reverts to where it was before...WHICH IS EXACTLY WHAT HAPPENED IN SWEDEN WHEN THEY RING-FENCED LOSSES.
Banking would also be destabilised and credit would stall again.
So this tax would cause huge loss in property values, hardship, destabilise banking, reduce consumption (credit will tighten and consumption drop), and kick off another recession....
I ignored it in my overview above as a clever idea that does not work in the real world. A cynic would observe that it makes the other options seem more palatable.
Also RFRR requires a lot of work for IRD, is subject to abuse (through manipulating valuations) and will stimulate heavy leveraging.
Example of Potential Abuse of the Tax
Example 1
1. Little Jonny owns a rental worth $300k with debt of $250k.
2. He pays RFRR tax on $300k - $250k = $50k times 6%*33%, $1k tax.
3. Little Jonny's friend has a similar house, similar suburb.
4. They sell each other their respective houses at $250k each, now 100% financed.
5. They achieve 100% financing by cross securing their respective investments to their homes, so they can borrow 100%. Valuers will now tend to view the market value of the houses as $250k, i.e. cost.
5. Now Little Jonny has zero tax to pay, under RFRR, $250k (MV) - $250k (debt) = $0 equity times 6%*33%=$0 tax, i.e. no tax.
Is this tax avoidance? Probably, but the point is, the tax is open to abuse.
Example 2
1. Little Jonny owns a rental worth $300k with debt of $250k.
2. He pays RFRR tax on $300 k -$250k = $50k times 6%*33%, $1k tax.
3. Little Jonny's friend has a similar house, similar suburb.
4. They sell each other their respective houses at $350k each, and loan each other $50k - now they are 100% financed and pay no equity tax.
There are a hundred permutations of ways to do this via trusts etc. Is this tax avoidance? Probably - but the point is again, that the tax is open to abuse.
I give Key and the Nats more credit than to bring in something this radical, this dangerous. They are pro-business and clever people - no question about that.
They understand that undermining consumption by destabilising banking, kicking off another recession and causing mass insolvency, is political suicide and not in the public interest. There is a better way in the other options of getting there (to a level playing field and weaning Kiwis off property investment – if that is what the Government wants), and the change needs to be more gradual.
Summary
Gilligan Rowe & Associates are 100% opposed to Risk Free Rate of Return. We see it as a clever idea that does not work in New Zealand at this time. We don't believe the government will bring it in - we give them credit for being rational.
Someone might like to email this to Mr English or Mr Key if they agree with our thoughts, or create their own version. My advice is to please be respectful and constructive in what you send them.
Use the following email addresses:
[email protected]
[email protected]
Hi Salesh, I just wanted to send you an email on behalf of GRA to say how fantastic we have found your company to date. As you know, Ben and I joined GRA a couple of months ago and have just found you so amazingly helpful in getting our new property set up correctly and sorted out. We have what I would consider a rather complicated structure as a result and it’s a fantastic feeling to know that we are getting everything done in the best way possible. We have just had approval to put a minor dwelling on the property which will make a massive difference in terms of cash flow and obviously value, something we would never have even thought of without GRA and which we are very excited about. During the buying process we attended a seminar with Matthew and from the outset thought he was fab. We therein signed up for property school and found this nothing short of fantastic. The content was relevant, up to date and comprehensive, but more importantly it was taught in a way that we could actually understand and really get value out of. I wanted to mention also, that everybody GRA have recommended to us has been just so efficient and absolute masters at what they do. A wonderful network of people that we feel very lucky to now be able to call on. From Kris Pederson and Bryan Rist who put our mortgage together to the insurance guys they then referred us to, I’m super impressed. Within GRA, Ellery has probably turned things around for us faster than I’ve ever known before, something which we appreciated so very much when it came to crunch time. She’s always a pleasure to deal with and again, we’re stoked. We’ve just settled on the property today and are about to go and get the keys. I’m pretty pumped and hence this email is probably rather excitable. So, a massive thank you to you Salesh, the partners for such a fabulous 6 weeks at property school and everyone at GRA for their help. May this be the start of our property empire. Thanks again, - A & B - July 2015
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